The Optimal CFO? Depends on Industry Growth Rate

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Last month, in our Square-Off debate forum, CFO presented five opinions on the question of whether an accounting background is important to today’s finance chiefs. The views given were divergent, well-stated, and in some cases startling.

Now comes a look at the issue from academia, with three business school professors reaching a conclusion that adds fuel to the debate. That is, “accountant CFOs” are better suited than non-accountants for low-growth industries, the academicians say. But they fare less well in high-growth sectors.

A paper in the May issue of the Journal of Accounting and Economics documented the results of a study of 2,524 and 2,546 “firm years” — one year for one company — in low-growth and high-growth industries, respectively, between 2000 and 2010. “Accountant CFOs” were identified as those with CPAs or experience working as an external or internal auditor or controller at some point before their appointment as CFO of a publicly held company.

“High-growth industries” were those that, in a particular year, were in the top quartile of the Fama and French 48 industries (excluding financial and utilities industries) in terms of analysts’ three-year EPS growth-rate forecasts issued the prior year. During the study period, examples of high-growth industries included business services (which incorporates software), electronic equipment, and pharmaceuticals, while transportation, oil/petroleum, and heavy machinery were examples of low-growth industries.

The results were stark. Accountant CFOs in high-growth industries were associated with 7.4% lower investment expenditure and a 14.6% lower likelihood of engaging in external financing. “Lower investment in risky projects and limited exposure to capital markets are both consistent with greater risk aversion on the part of accountant CFOs,” wrote the authors, Rani Hoitash of Bentley University and Udi Hoitash of Northeastern University, and Ahmet Kurt of Suffolk University.

On the other hand, for companies in low-growth industries whose revenue was increasing, accountant CFOs were associated with 19% greater cost efficiencies.

Another research result bore out that last statement. Company value — as measured by “Tobin’s Q,” or the ratio of the market value of a company’s assets to the replacement cost of those assets — was 3.7% higher among low-growth-industry firms with accountant CFOs. But at high-growth industry firms with accountant CFOs, company value was 4.4% lower.

“These are all very significant numbers,” Kurt tells CFO in an interview. “And they are after controlling for [many variables], including firm size, growth opportunities, R&D expense, leverage, and firm age.”

Like many academic studies, this one took years to complete, and the results could have been somewhat different if data from recent years were included, Kurt acknowledges.

“After Sarbanes-Oxley, companies wanted CFOs with stronger accounting backgrounds,” he notes. “But based on our reading of the financial press, many companies may be realizing that’s not working out for them, because they’re hiring fewer and fewer accountant CFOs.”

Still, the research results point to a significant career consideration for CFOs. “When they think about making career moves, they want to add something to their career — better results, performance, or reputation,” Kurt says. “You’ve got to think, ‘I am going to be a good fit there?’ And here is evidence that certain types of CFOs may not be a good fit for particular industries.”

Turn that around, and companies too should have a strong takeaway from the research. In fact, given the research results, why should a high-growth company ever hire an accountant CFO?

However, the paper points out a number of reasons why companies may not optimally choose their CFOs:

Given that the evidence on the benefits of certain kinds of qualifications and backgrounds is limited, no common best practices or guidelines exist for choosing CFOs.

Executives often do not possess all of the desired qualifications, leading companies to prioritize certain qualifications over others.

A CEO must invest substantial resources, particularly time, in hiring a CFO. If the company already has a competent CFO with whom the CEO has a good rapport, the CEO is unlikely to want to replace that person because of the lack of a particular qualification or type of expertise.

The board and the CEO may perceive the monetary and time cost of searching for a new CFO to be too high.

There may be a lack of equilibrium in the demand for and supply of CFOs.